Transcript Elasticity - mrcjaeconomics

ELASTICITY
PRICE ELASTICITY OF DEMAND
Price elasticity of of demand is a measure of how
much the quantity demanded of a product
changes when there is a change in the price of
the product.
 PED = Percentage of change quantity demanded
of the product
----------------------------------------------------------------Percentage change in price of the product

Example – A publishing firm discovers that when
they lower the price of one of their magazines
from $5.00 to $4.50 the number of magazines
that are bought rises from 200,000 to 230,000.
 The price has fallen by 50 cents so this a change
or -10%

Ped = -50x 100 = -10%
100

The quantity demanded has increased by 30,000
from the original demand of 200,000 an increase
of 15%
30,000x 100 = 15%
200,000
o
If we put the two values into the PED equations
we get 15% 10% a value of -1.5
 The
negative value indicates that there is
an inverse relationship between price and
the quantity demanded.
 In order to make thing easier economist
unusually ignore the the negative value so
the PED for the magazines would be 1.5
Range of values = 0 to Infinity, with 0 and
infinity being theoretical
 Just to remind you - Values of PED are always
expressed as positive numbers





Price Elasticity of
Demand – (PED)
Two extremes – no
REAL examples of these
extreme points!
The demand is perfectly
inelastic – it is
completely unresponsive
to price changes.
No matter what the
price is demand will
always be the same.
At the price (p1) the
demand is curve will
go on forever so the
quantity demanded is
infinite.
 However if the price is
raised above this price
even by the smallest
amount the demand
will fall to zero.

INELASTIC DEMAND
The Value of PED is less than one and greater
than zero.
 If a product has inelastic demand, then a change
in the price of the product leads to a
proportionally smaller change in the quantity
demanded of it.
 This means that if the price is raised, the
quantity demanded will not fall by much in
comparison, and so the total revenue gained by
the firm (the number of units sold x the price of
the product) will increase.

ELASTIC DEMAND
 The
value of PED is greater than one
and less than infinity.
 If a product has elastic demand, then a
change in the price of the product leads
to a greater than proportionate change
in the quantity demanded of it.
 This means that if price is raised, the
quantity demanded will fall by more in
comparison, and so the total revenue
gained by the firm (the number of units
sold x the price of the product) will fall.
UNIT ELASTIC DEMAND
The value of PED is equal to one.
 If a product has unit elastic demand, then a
change in the price of the product leads to a
proportionate, opposite, change in the quantity
demanded of it
 This means that if price is raised by
percentage then the quantity demanded will fall
by the same percentage and so PED is equal to 1
and the total revenue gamed by the firm (the
number of units sold x the price of the product)
will not change.

A
20
B
15
C
10
D
5
0
50
100 150 200 250
When the price falls
form $20 to $18,
quantity demanded
increases from 60 to 80
unites. (A to B)
When price falls from
$10 to $8, quantity
demanded increase from
160 to 180 units.
(C to D)
“NOT ALWAYS THE SAME!!!”
PED = 3.3
(Elastic )
A
20
15
10
B
Demand
becomes
less
elastic
PED = 0.625
(Inelastic)
C
D
5
0
50
When the price falls
form $20 to $18,
quantity demanded
increases from 60 to 80
unites. (A to B)
When price falls from
$10 to $8, quantity
demanded increase from
160 to 180 units.
(C to D)
100 150 200 250
MATHEMATICAL EQUATION
It is a common mistake for students to assume
that elasticity is a measure of the slope of the
demand curve and that the value is always the
same at any point on the curve.
 This is not the case.
 Low-priced products have a more inelastic
demand than high-priced products,
consumers are less concerned when the price of
an inexpensive product rises than they are when
the price of an expensive product rises.

DETERMINANTS OF PRICE ELASTICITY OF
DEMAND
The number and closeness of substitutes:
 The number and closeness of substitutes that are
available is certainly the most important
determinate of PED. It is fair to say that the
more substitutes there are for a product, the
more elastic will be the demand for it
 Also, the closer the substitutes available, the
more elastic will be the demand.
 Elastic – household good, food, (meats fruits
vegetables)
 Inelastic – oil demand falls relatively little with
increase of price.

THE NECESSITY OF THE PRODUCT AND
HOW WIDELY THE PRODUCT IS DEFINED:


Food is a necessary product. Indeed, if we do not have
food, then we will die, so it is very necessary.
So we would expect the demand for food to be very
inelastic, which it is. However, if we define food more
narrowly and consider meat, we would expect the
demand to be less inelastic, since there are many
alternatives, such as vegetables. Once again, if we
then define meat more narrowly and consider
chicken, beef, lamb, and pork, we could once again
reasonably assume that the demand for each would
be relatively elastic, since the consumer can easily
change from one type of meat to another, if the price
of one rises.

As the product is defined even more narrowly,
into chicken products and then identical, but
branded, chicken products, demand becomes even
more elastic.
Very inelastic demand
Food
Meat
Beef
Chicken
Chicken nuggets
Brand A nuggets
Very elastic demand
Vegetable
Pork
Chicken wings
Brand B nuggets
It is worth remembering that for many goods,
necessity will change from consumer to
consumer, since different people have different
tastes and necessity is often a subjective view.
 For example, in Malaysia, chicken is very popular
among the population and so the demand for it is
less elastic than it would be in Italy, where it is
not valued as highly.
 Necessity may go to extremes when individuals
consider products to be very ‘necessary”, such as
habit-forming goods, like cigarettes alcohol or
hard drugs Such products tend to have inelastic
demand.

THE TIME PERIOD CONSIDERED:
As the price of a product changes, it often takes
time for consumers to change their buying and
consumption habits.
 PED thus tends to be more inelastic in the short
term and then becomes more elastic the longer
the time period it is measured over.
 It may take people some time to locate
substitutes or figure out how to use them or even
how to do with out certain products.

CROSS ELASTICITY OF DEMAND
Cross elasticity of demand is a measure of how
much the demand for a product changes when
there is a change in the price of another product.
 The equation

XED = Percentage change in quantity demanded of the product X
Percentage change in price of product Y
Owner of the noodle stand finds out that his
competitor, a dumpling stand, lowers the price of
his plate of dumplings from 20¥ to 18¥ , then the
quantity of bowls on noodles he sells each week
falls from 400 to 380.
 The price of the competitors dumplings have
fallen by 2¥ from the original price of 20¥ a
change of -10%
 The quantity demanded of the bowl of noodles
has fallen by 20 from the original demand of 400
a change of 5%
 Put the two values into the equation for XED we
get
which is a value of +0.5
-5

-10
THE RANGE OF VALUES FOR CROSS ELASTICITY
OF DEMAND
Unlike price elasticity of demand, where the vast
majority of products have a positive value
for PED, the value of XED may be positive or
negative and the sign is important, since it tells
us what the relationship between the two
goods in question is.
 If the value of XED is positive, then the two
goods in question may said to be substitutes for
each other.
 Products that are very close substitutes will have
a higher positive value than products that are
not so close.

Two types of cheese may be very close substitutes
in the view of consumers, and so a rise in the
price of one will lead a significant fall in the
demand for it and a large increase in the
demand for the competitor’s cheese.
 So there would be a high positive value for XED.

If the value of XED is negative, then the two
goods in question may he said to be complements
for each other.
 Products that are very close complements will
have a lower negative value than products that
are not so close.
 A computer gaming machine and the games that
are played on it may be very close complements
for consumers. A rise in the price of the gaming
machine may lead to a significant fall in the
quantity demanded of it and so a large fall in the
demand for the games.
 Thus there would be a strong negative value for
XED.

Some products (chocolate and rollerblades) are
not connected.
 A increase in the price of chocolate will have no
effect on the demand for rollerblades.
 The value of XED is zero and we say the two
products are unrelated.

Firms need to be aware of the XED for the
products that they produce.
 It is essential that firms are aware of the possible
impact on the demand for their products that
may arise if there is a change in the price of a
close rival’s products and vice versa
 Firms that produce complementary products,
need to be aware of the effect that any
price change they make on one product might
have on the demand for complementary products
that they also produce.

XED Value
Negative
Zero
Positive
Relationship
Close
Comp.
Remote
Comp.
Unrelated
products
Remote
Subs
Close
Subs
INCOME ELASTICITY OF DEMAND (YED)
Formula and definition
Income elasticity of demand is a measure of how
much the demand for a product changes when
there is a change in the consumer’s income.
 It is usually calculated by using the equation
below:

YED = Percentage of change in quantity demanded of the product
Percentage change in income of the consumer
A person has an increase in annual income from
$60,000 per year to $66,000.
 She then increases her annual spending on
clothes from $2,500 to $3,000.
 With this information, we can calculate her
income elasticity of demand for clothes.
1 Her income has risen by $6,000 from an
original income of $60,000, which is a change of
+ 10%. This is calculated by the equation

+6,000 x 100= +10%.
60,000
The quantity demanded of shoes has increased by
$500 from an original demand of $2,500, which is a
change of +20%. This is calculated by the equation
500 x 100 = +20%.
2,500
 If we put the two values above into the equation for
 YED, we get ,
+20%
+ 10%
which gives a value of +2.

THE RANGE OF VALUES FOR INCOME
ELASTICITY OF DEMAND
Like XED, the sign obtained from the equation is
important.
 In this case, the sign of YED tells us whether the
product we are looking at is a normal good or an
inferior good.
 Remember that the demand for a normal good
rises as income rises and the demand for an
inferior good falls as income rises.

For normal goods, the value of YED is positive,
i.e. the demand increases as income increases.
 If the percentage increase in quantity demanded
is less than the percentage increase in income,
then a YED value between zero and one is
obtained and the demand is said to be incomeinelastic.
 If the percentage increase in quantity demanded
is greater than the percentage increase in income
then a YED value greater than one is obtained
and the demand is said to be income-elastic

NECESSITY GOODS
Necessity goods are products that have low
income elasticity.
 The demand for them will change very little if
income rises. For example, the demand for bread
does not increase significantly as income rises,
because people feel that they already have
enough bread and so will not increase
consumption.

SUPERIOR GOODS
Superior goods are products that have high
income elasticity.
 The demand for them changes significantly if
income rises.
 As people have more income and have satisfied
their needs, they begin to purchase products that
are wants, i.e. non-essential, in greater number.
 For example, the demand for holidays in foreign
countries likely to be income-elastic.

For inferior goods, the value of YED is negative,
because the demand decreases as income
increases.
 People start to switch their expenditure from the
inferior goods that they had been buying to
superior goods, which they can now afford.
 For example, the inexpensive for inexpensive
jeans falls as income rises because people switch
to buying branded jeans.

Quantity of potatoes demanded
An Engal Curve
Income
PRICE ELASTICITY OF SUPPLY (PES)
Formula and definition
 Price elasticity of supply is a measure of how
much the supply of a product changes when there
is a change in the price of the product.
 It is usually calculated by using the equation
below.
PES = Percentage change in quantity supplied of the product

Percentage change in price of the product
For example, a publishing firm realizes that they
can now sell their monthly magazine for $5.50
instead of $5.00.
 Because of this, they increase their supply from
200,000 to 230,000 magazines per month.
With this information, we can calculate the price
elasticity of supply for the magazine.
 The price has risen by 50¢ from an original price
of $5, which is a change of + 10%.
 This is calculated by the equation

50xlOO= -10%.
500
The quantity supplied has increased by 30,000
from an original supply of 200,000, which is a
change of 15%.
 This is calculated by the equation
30,000 x100 = 15%.
200,000
 If we put the two values above into the equation
for PBS, we get15%
10%
which gives a value of 1.5.
 The value of PBS will almost always be positive.

THE RANGE OF VALUES OF PRICE
ELASTICITY OF SUPPLY
The possible range of values for price elasticity of
supply usually goes from zero to infinity.
 Unlike PED, we will come across examples of
both extreme values as we continue our study of
economics.

s
A supply curve with the value of
zero. The supply is said to be
perfectly inelastic.
In the very short run, sometimes known as the
immediate time period, it is impossible for firms
to increase their supply straight away, no matter
what happens to price.
 There also may be a sudden demand for a
product that is seasonal so in the long run it will
not be sustained but firms do not want to employ
more factors of production.
 Ice cream in Scotland.

At the price P1. the supply curve
goes on forever
so the quantity supplied is infinite.
However, if price falls
below P1, even by the smallest
amount, supply will fall to zero, an
infinite change.
P1
s
In international trade, it is often assumed that
the supply of commodities, such as wheat,
available to a country for import is infinite
 The consumers in the country can have all that
they want as long as they are prepared to pay the
current world market price.
 The market in the country will have a “world
supply” curve is perfectly elastic at the current
world market price.
